More takeovers in the water works
The sale of Northumbrian to Li Ka-Shing could be just the start of a wave of deals in the water industry
Wednesday 03 August 2011
After weeks of speculation and uncertainty, the board of Northumbrian Water yesterday unanimously recommended that shareholders accept the 665p-per-share cash offer from Hong Kong billionaire Li Ka-Shing's Cheung Kong Infrastructure (CKI).
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The deal represents a 26.4 per cent premium to the share price before the takeover talks became public in late June, valuing the FTSE 250-listed utility at £4.7bn.
It also puts paid to warnings that the industry's most recent regulatory price review – which runs from 2010 to 2015 – set conditions so tough they would materially affect the industry's ability to attract investment. And with the watchdog Ofwat softening its stance on mergers and acquisitions, the CKI/Northumbrian deal could be the vanguard of a spell of consolidation in the fragmented water sector.
Sir Derek Wanless, the chairman of Northumbrian Water, yesterday described CKI's offer as being priced at an "attractive premium" to both the regulated capital value and the group's pre-offer share price.
"Whilst Northumbrian would have a strong future as an independent company, the offer fairly values the current and future prospects of the company," Sir Derek said.
CKI confirmed that Northumbrian would be incorporated into a new company, to be called UK Water, with the existing management team remaining in place.
H L Kam, the group managing director of CKI and a director of UK Water, said: "We attach great importance to the skills and experience of the existing management and employees of Northumbrian and believe they will be an important factor in the continuing success of the Northumbrian Group."
CKI already owns a spread of infrastructure assets in the UK, including electricity networks that it bought from the French group EDF for £5.8bn last year.
But to avoid a Competition Commission referral for the Northumbrian deal, the group is off-loading its other water-sector asset, Cambridge Water, to HSBC for £74m. The decision on Cambridge Water reflects Ofwat's historical reluctance to allow mergers in the sector, borne out of its concern to maintain a broad base of performance comparators. But earlier this year the regulator's chief executive, Regina Finn, hinted at a relaxation of merger controls as part of wider plans to boost competition in the sector. And there is now a growing expectation across the once-sleepy industry of major changes to come.
In part, it is the stringencies of Ofwat's own most recent price and investment review – know as PR09 – that is piling pressure on water companies and nudging the sector towards consolidation.
Duncan Michie, a director in the utilities consulting practice at PricewaterhouseCoopers, is expecting more takeover talks, among both listed and unlisted companies.
"The Northumbrian deal demonstrates that in spite of PR09, there is still value in the water sector," Mr Michie said.
"And there's a whole range of potential efficiencies that water companies can't fully exploit at the moment, but which they will be able to take advantage of as we see changes to the merger regime," he added.
The next step could be either typical consolidation through mergers and acquisitions, or it could be the adoption of new models for exploiting economies of scale, such as joint ventures, or resource-sharing arrangements, or water trading across the industry's traditionally discrete geographical regions.
"We are at the point where there is pressure to innovate, either through consolidation or through thinking of new ways of getting the benefits of scale," Mr Michie said.
There is certainly considerable support for deregulation among some of the biggest players in the water sector.
Tony Wray, the chief executive of FTSE 100-listed Severn Trent, has long been a vocal proponent of change, calling for the sector's 21 companies to come down to as few as 10, and for water trading to make the most of scarce resources.
According to Mr Wray, such developments are the only way to meet the challenge of climate change.
"To guarantee security of supply and manage the effects of flooding we need more efficient networks, and that is best achieved by having some consolidation," he told The Independent. "Consolidation could also deliver greater capital efficiency – which is significant because tens of billions of pounds worth of investment are still required."
There are already signs of movement. Industry insiders are discussing HSBC's likely sale of Cambridge Water. Agbar is reportedly looking to sell its 70 per cent holding in Bristol Water, which abuts both Severn Trent and Wessex Water territory. And there is also growing speculation about the future of Veolia's three water-only subsidiaries. "We may be at the start, but it is not going to be an overnight transformation," Mr Wray said. "It will be a gradual change in response to the challenge about how the industry finances its massive capital requirements."
Meanwhile, although the water sector's long-term, stable returns are looking more attractive than ever – even compared with once-reliable sovereign debt – there are significant questions about where the finance for future consolidation deals might come from.
Deep-pocketed CKI may not be affected by the credit crunch. But the infrastructure funds that have snapped up the majority of Britain's once-listed water companies have relied on the kind of cheap debt that is in short supply in the aftermath of the credit crunch.
"There aren't that many CKIs around so the interesting question is whether the infrastructure funds will come back into the market," Doug King, a vice chairman at Deloitte, said. "There are attractive investments, and there will continue to be; whether there are the right buyers is questionable."
There is also another slug of regulatory uncertainty to contend with. Although PR09 has set out thereturns for the five years up to 2015, Ofwat is also exploring options for boosting retail competition, and there is also a Government white paper that will look at the long-term shape of the industry. That white paper is due to be published in November.
"You could take the view that the Government and regulator will be sensible, but most infrastructure funds would want clarity from the white paper before doing anything significant," Mr King said.
So, while the uncertainty over Northumbrian Water's future appears finally to be settled, the upheavals for the industry as a whole may just be only beginning.
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